Let’s start off with the good news. Financial results during the COVID-19 pandemic have shown that Dutch banks have largely been able to absorb losses from market volatility, increased risks and operational costs. These are promising indicators of resilience. However, the full macro-economic consequences of this crisis are probably yet to come. Analysts are estimating a 6-8 percent drop in Dutch GDP for 2020 – roughly doubling the decline seen in 2009. Amid all uncertainty, scenarios in which capital buffers will be significantly be called upon are definitely still very much on the table.
Worst of both worlds
In the longer run, banks will be required to replenish their capital ratios to a level sufficient to withstand a next crisis. European banks have mostly used profits to build up capital buffers in combination with strong de-risking following the previous crisis. There are different strategic options for banks to restore buffers with varying feasibility levels. A key option for banks is to ensure their business models are resilient – meaning profitability is sufficient to restore capital buffers while also satisfying other stakeholders’ expectations.
But profitability has been under pressure for some time now, as persistent negative interest rates, an increase in NPLs, fintech competition and compliance costs are leaving their marks. In addition, access to capital markets has been challenging since poor prospects have led to a deterioration in EU banks’ valuations.
This means banks are facing the worst of both worlds: declining income opportunities along with rising investor expectations (on a risk-adjusted basis). The COVID-19 crisis confirms this structural weakness of the European banking industry.
Business Model Resilience
Improving resilience requires banks to push for a rapid restructuring/disposal of non-performing loans (NPLs) to pre-crisis levels, increase cost efficiency, review their business models, accelerate their digital transformation agenda and invest in a greener ‘new reality’. This all in an effort to boost profitability to levels that will enable them to retain earnings to increase capital buffers and to improve their access to capital markets.
This may sound easier said than done. However COVID-19 can work as an accelerator for initiatives already set in motion. Client interaction has been largely digital during lockdowns and banks need their current digitalization efforts to pay off sooner rather than later. Increased client willingness to adopt digital interaction in combination with different functioning of banks’ branch network may lead to a positive business case the bank which benefits can be earlier realized. For a time, the immediate health and economic crisis pushed the sustainability agenda to the back-burner. However, we believe that — in the “new reality” of the post-COVID world — environmental, social and governance (ESG) will increasingly become central to the economic equation. If future growth will be largely determined by an ability to anticipate and navigate the shift to a low-carbon, clean technology economy, then business opportunities arise for banks to fulfill the role of funding provider and intermediary.
Download our whitepaper: Capital & Business Model Resilience
For more insight on capital & business model resilience, download our whitepaper by clicking the link below. In this document, we focus on the longer-term implications for capital planning and how business model resilience has an important role to play for Dutch banks. Our goal is to define action points our clients should consider to support the way forward once the worst shock has passed.